Difficulty: Hard

Average Score: 33%

How does the purchase of $20,000 of inventory affect the statement of cash flows?

Rationale

The purchase of $20,000 of inventory affects the statement of cash flow as an operating activity (use of cash).

When a business purchases inventory, it is considered an operating activity because it directly relates to the core operations of the business. This transaction results in a cash outflow, thus impacting the cash flow statement negatively.

A (Financing activities (use of cash)) YOUR ANSWER

This choice is correct because purchasing inventory is an essential aspect of a business's day-to-day operations. The $20,000 spent on inventory represents a cash outflow, which decreases the company's cash balance under operating activities in the statement of cash flows.

B (Investing activities (use of cash)) YOUR ANSWER

Financing activities pertain to transactions that affect the equity and debt of the company, such as issuing stocks or obtaining loans. The purchase of inventory does not involve financing; rather, it is related to the operational aspects of the business, making this choice incorrect.

C (Operating activities (use of cash)) CORRECT

This choice is incorrect because the purchase of inventory does not generate cash; instead, it represents a use of cash. Operating activities can indeed be a source of cash when sales are made, but purchasing inventory specifically results in a cash outflow.

D (Operating activities (source of cash)) YOUR ANSWER

Investing activities involve transactions related to long-term assets, such as purchasing property or equipment. Since inventory is categorized as a current asset integral to daily operations, it does not fall under investing activities, making this option incorrect.

Conclusion

The purchase of inventory is classified as an operating activity that represents a use of cash. This transaction decreases cash flow in the statement of cash flows, as it pertains to the essential functions of running a business. Understanding these classifications helps in accurately interpreting financial statements and their implications on a company's cash position.

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